standby

Geoff Marsden is the main shareholder of the Fourways Garage Ltd (he has 80% of the shares and his wife owns 20%). Geoff runs the garage and takes a salary of £30,000 a year, gross. The site is rented, so the company’s fixed assets are its fixtures, fittings, vehicles and equipment.

As well as selling fuel and servicing cars, the Fourways garage also sells new cars too. Used cars are often taken in part exchange, repaired, serviced and re-sold. The used car salesmen often grumble that the new car salesmen value the trade in car too highly, making it impossible for them to make a good profit. Geoff is waiting for you to prepare his accounts and to advise him on this problem.

The business is effectively split into five departments, each with its own inventories and marketing characteristics. These are: new cars, used cars, spares, maintenance, and petrol sales. Geoff likes to run each one of them as a separate profit centre. Consequently he wants to calculate a sales revenue and cost of goods sold for each one of them. He also charges each department with its directly traceable employment costs, to give him a departmental gross profit figure. The average selling price of a new car was £20,000, of a used car, £12,000, of spares £170 and of petrol 140 pence a litre. Maintenance charged approximately £100 an hour. He employed 5 men in the maintenance department, who worked a thirty-five hour week for fifty weeks of the year.

Most of the sales revenue is settled in cash or by credit card, although there are some business credit accounts.

Geoff did not have to ‘buy’ the new cars until he had sold them – the suppliers, in effect, still owned them even though they were in his show room. Consequently the cost of goods sold for new cars is the same as the cost of purchases.

The used car department costs included any repair work that needed to be done on the cars as part of its cost of goods sold. In order to avoid arguments between the new car salesmen and the used car salesmen the ‘blue book’ value is used as the acquisition cost of the used car, from the used car salesmen’s point of view. Thus if the new car salesman had allowed a higher value on the trade-in than ‘blue book’ their own department had to suffer the difference. No VAT was charged on either the purchase or sale of used cars, instead the company has to pay VAT on the difference between the purchase cost and the sales price of the used cars.

The spares department ‘sold’ its spares to maintenance at normal retail prices less 15% because it was a captive customer. This led to problems at times because if the spares department had to choose between selling its last item in inventory to a retail customer or to maintenance, spares dept. would make more profit if they sell to the retail customer – to the annoyance of maintenance to put it mildly!

Maintenance charged its work on an hourly rate basis plus the cost of parts.

These charges applied both to the used car department and to its retail customers

Calculating the cost of goods sold for petrol sales was straight forward; the cost of petrol bought plus opening inventories less closing ones.

Having arrived at the gross profits of each profit centre (in their own columns) Geoff then transferred them to the main P&L (column) so that he could calculate his net profit.